Bank Leumi le Israel B M : Standard & Poor Affirmed the bank rating A /Negative/A 2

Bank Leumi le-Israel B.M.

Primary Credit Analyst:

Pierre Hollegien, Paris + 33 14 075 2513; [e-mail]

Secondary Contacts:

Regina Argenio, Milan + 39 0272111208; [e-mail]

Matan Benjamin, RAMAT-GAN + 44 20 7176 0106; [e-mail]

Table Of Contents

Rating Score Snapshot

Credit Highlights

Outlook

Key Metrics

Anchor: 'bbb' For Banks Operating Only In Israel

Business Position: Leading Domestic Player

Capital And Earnings: Higher-For-Longer Interest Rates Support Profitability

Risk Position: High And Increasing Concentration In Real Estate-Related Lending

Funding And Liquidity: Sound Liquidity And Customer Deposits Underpin The Funding Base

Comparable Ratings Analysis (CRA) Adjustment: One Notch Of Uplift Due To Strong Earnings Capacity

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Table Of Contents (cont.)

Support: One Notch Of Uplift For Government Support Environmental, Social, And Governance

Group Structure, Rated Subsidiaries, And Hybrids Key Statistics

Related Criteria

Related Research

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Bank Leumi le-Israel B.M.

Rating Score Snapshot

Issuer Credit Rating

A-/Negative/A-2

Credit Highlights

Overview

Key strengths	Key risks
Market leader in Israel, with a strong presence in	Large and growing concentration in the real estate sector, potentially adding pressure to asset
all key business lines.	quality in a more challenging economic environment.
Large domestic customer deposit base.	Large investment securities and pension liabilities, which create volatility in capitalization.
Resilient profitability despite weakened	High geopolitical and security risks.
economic environment.

Leumi's strong franchise and large and granular deposit base are credit positive. Leumi is a universal bank that serves the full spectrum of customers in Israel, which provides reasonable earnings and balance-sheet predictability. It benefits from large core deposits base, accounting for about 90% of its funding. Despite some deposit-pricing competition, its revenues remain resilient.

Higher-for-longer interest rates are a tailwind helping loss-absorption capacity and supporting the bank's

capitalization. Interest rates are also supporting its profitability, as are cost-efficiency initiatives. We expect credit losses to remain high at 40 basis points (bps) per year on average in 2024-2026. Leumi's superior earning capacity represents a strength compared to peers and a buffer at the current rating level. We forecast that Leumi's risk-adjusted capital (RAC) ratio will improve slightly to 8.4%-8.8% in 2026, from 8.4% as of December 2023.

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Bank Leumi le-Israel B.M.

However, the economic slowdown and uncertain environment coupled with Leumi's stronger-than-peers growth in

construction and real estate represent a risk. We forecast NPLs to increase to about 1.4% by 2026 from a low 0.96% as

of March 31, 2024 due to high interest rates and the Israel-Hamas conflict's effects on economic performance. Strong

growth in the construction and real estate segment over the past few years are exacerbating tail risk.

We factor into our ratings our view that Israel (A+/Negative/A-1) would provide extraordinary support to the bank in

the event of financial distress.

Outlook

The negative outlook on Leumi mirrors that on the sovereign and reflects our view that an escalation of the war could have negative implications for Leumi's creditworthiness over the next 12-24 months.

Downside scenario

We could lower the rating on Leumi if we lowered the rating on Israel because we would then consider it less likely that the government would provide extraordinary support to Leumi in case of need. We could also lower the rating on Leumi if we considered that security risks had escalated, with negative consequences for the banking sector and Leumi's asset quality, capitalization, or earnings.

Upside scenario

We could revise the outlook to stable if we revised the outlook on Israel to stable and thought that security risks and pressures on domestic economic prospects had lessened.

Hybrids

We do not assign outlooks to bank issue ratings. However, we will continue to notch down the ratings on Leumi's hybrids from the stand-alone credit profile (SACP). Therefore, we would lower the rating on the bank's rated subordinated instruments if we were to revise Leumi's SACP downward.

Key Metrics

Bank Leumi le-IsraelB.M.--Key ratios and forecasts

		--Fiscalyear-ended Dec. 31 --
(%)	2022a	2023a	2024f	2025f	2026f
Growth in customer loans	12.2	9.5	5.4-6.6	7.2-8.8	5.4-6.6
Net interest income/average earning assets (NIM)	2.8	2.9	2.4-2.6	2.1-2.4	1.9-2.1
Cost to income ratio	38.7	32.3	34.5-36.336.2-38.1	37.9-39.8
Return on average common equity	16.9	13.5	11.5-12.110.3-10.9	9.9-10.4
New loan loss provisions/average customer loans	0.1	0.6	0.5-0.5	0.4-0.4	0.3-0.3
Gross nonperforming assets/customer loans	0.8	1.1	1.5-1.6	1.6-1.7	1.3-1.4

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Bank Leumi le-Israel B.M.

Bank Leumi le-IsraelB.M.--Key ratios and forecasts	(cont.)
			--Fiscalyear-ended Dec. 31 --
(%)		2022a	2023a	2024f	2025f	2026f
Risk-adjusted capital ratio	9.7		8.4	8.5-9.0	8.4-8.9	8.4-8.8
All figures are S&P Global Ratings-adjusted.a--	Actual. e Estimate. f----	Forecast. NIM Net interest margin.--

Anchor: 'bbb' For Banks Operating Only In Israel

We use our Banking Industry Country Risk Assessment's economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in Israel is 'bbb'.

Israel-based banks benefit from the wealthy and diversified domestic economy, but they display some concentration in their lending books and are vulnerable to geopolitical risk. In our view, the material escalation of geopolitical and security risks that Israel faces following the onset of the Israel-Hamas war will affect Israel's economic performance in 2024. We forecast real economic growth at 0.5% in 2024, which, excluding the pandemic year, 2020, will be the weakest performance in decades. While we expect growth will rebound in 2025 by 5%, it remains uncertain whether there could be longer-term scarring for the Israeli economy. In addition, an escalation of conflict could present additional security and social risks for Israel, with a deeper impact on the domestic economy. Economic slowdown, coupled with higher debt service, will impact asset quality, in our view. Israel's real estate sector, which represents a large 20% of banks' loan books, is among the most vulnerable to current developments, in addition to unsecured lending, tourism, small businesses, and the services sector. In this context, we expect credit losses to remain elevated after having reached about 50 bps in 2023.

Low funding risk and the proactive regulator support the industry. The Israeli banking sector benefits from a strong funding profile and a net external creditor position, which both provide a cushion in the challenging environment. Prudent regulatory oversight somewhat mitigates risks of concentration and geopolitical instability. Israel-based banks' profitability is benefiting from a recovery in lending growth, high interest rates, and continuous cost-cutting initiatives. Competition among banks and nonbank financial institutions somewhat constrains margins and fees.

Business Position: Leading Domestic Player

Our assessment of Leumi's business position reflects its strong franchise in its home market, where it enjoys a significant presence in all segments (charts 1 and 2).

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Bank Leumi le-Israel B.M.

Chart 1	Chart 2

The bank aims to maintain its current market shares in most segments while continuing to grow in mortgages, amid recovered demand after negative pressure from high interest rates and conflict. It also wants to grow its exposure to the construction industry, but is taking a more cautious approach. At the same time, Leumi will continue to increase its digitalization and maintain tight cost controls.

Its diversified revenue base provides business stability. However, larger operations than peers in the capital markets and investment banking segments create some volatility in its revenue base (chart 3).

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Bank Leumi le-Israel B.M.

Chart 3

Leumi has significantly expanded its business after the pandemic, but has mostly focused on construction and real estate segments, which we consider inherently riskier. We acknowledge that underwriting standards have remained conservative, but we think that rapid growth in the real estate segment might expose Leumi to risks amid tougher economic conditions. We expect Leumi's lending growth to slow moderately over the next two-to-three years, due to the economic slowdown, lower confidence, and still-tight financing conditions.

On the international front, Leumi's main exposure is its investment in Valley National Bank (Valley). Leumi cooperates with Valley to serve the U.S. operations of large Israeli companies that are important Leumi customers. It is important for Leumi to have a presence in the U.S. because of the economic, political, and historical ties between the U.S. and Israel.

Leumi's exposure to the U.S .

Leumi sold its 85% stake in Bank Leumi USA to Valley on April 1, 2022, in exchange for about 14.2% of Valley and cash, for about US$1.2 billion. While we think that the sale reduced Leumi's operational risk, we believe it magnified its exposure to the turmoil at U.S. regional banks and added some volatility to the bank's performance given Valley's sizable exposure to CRE of about 5x its capital (see "Outlooks On Five U.S. Regional Banks Revised To Negative From Stable On Commercial Real Estate Risks; Ratings Affirmed," March 26, 2024). Valley's initial ILS3.6 billion investment has been repeatedly written down to reflect Valley's weaker share price performance, in line with other U.S. regional banks. We deduct Leumi's entire investment in Valley--currently estimated at about ILS2 billion--from our measure of capital.

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Bank Leumi le-Israel B.M.

Capital And Earnings: Higher-For-Longer Interest Rates Support Profitability

We believe Leumi's profitability will continue to support its capital, but we expect it to improve only marginally due to sustained credit growth and an increase in shareholder distributions. We anticipate that Leumi's RAC ratio will slightly progress to about 8.4%-8.8% in 2026, from 8.4% as of December 2023 (pro forma for new BICRA parameters; see "Various Rating Actions On Israeli Banks On Increased Geopolitical Risks; All Outlooks Negative," May 2, 2024; chart 4).

Chart 4

Interest rates should remain high for 2024--as a result of the Bank of Israel's cautious approach in this uncertain environment--thereby providing a tailwind to revenues. Assuming geopolitical risk recedes, we expect interest rates to moderately decline from 2025. We anticipate a still-high net interest margin (NIM), lending expansion, and cost-containment measures to sustain return on equity (RoE). We forecast RoE will remain above 10% but be volatile amid provisioning efforts and extraordinary items (chart 5).

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Bank Leumi le-Israel B.M.

Chart 5

In our forecast we factor in:

• NIM gradually declining toward about 2.0% in 2026 from 2.89% as of December 2023 balancing still-sustained lending growth, at about 6%-7%, and a high portion of interest-bearing customer deposits.
• Muted fee performance in 2024, resuming thereafter due to its diversified fees-based business.
• Still-highcredit losses, although moderately declining to about 40 bps on average in 2024-2026.
• We also take into account the new windfall tax for the sector that will extend until end-2025.
• An increased payout ratio of 40%-45% over the three-year period.

Leumi's regulatory capital and leverage ratios are comfortably above regulatory requirements. The group's CET 1 ratio stood at a historically high 11.98% as of March 2024, above the minimum target of 10.23%. We do not expect the bank would maintain its current level of capitalization in a more stable geopolitical environment, as it usually works with narrow buffers. This is because Israeli banks use the standardized approach to calculating risk-weighted assets and apply the BOI's more conservative requirements to some real-estate-related exposures. We don't regard this as a risk because we understand that the regulator is comfortable with these narrow margins and that the bank is not willing to approach the minimum threshold.

Capitalization is more volatile than peers' due to the large securities portfolio and defined benefit pension fund, which are sensitive to interest rate developments. Interest rates have the opposite effect on mark-to-market evaluations of the

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Bank Leumi le-Israel B.M.

bank's securities accounted at fair value and on unrecognized losses for employee benefits. Unrealized losses

associated with Leumi's bonds reached about ILS1.70 billion as of March 31, 2024, versus a gain of about ILS874

million as of December 2021, while unrecognized losses for employee benefits declined to ILS743 million as of March

31, 2024, from a high ILS3.5 billion as of December 2021.

Regulatory Capital Ratio Calculations

The BOI calculates its regulatory capital ratio differently to how we calculate RAC. BOI fully captures unrealized losses or gains on securities accounted at fair value in its regulatory capital calculation. Since July 2022, the BOI has allowed Leumi to spread over four quarters the net amount of the change in the value of assets designated for hedging its employee-benefits liability derived from movement in the discount rate (the bank does not disclose the amount).

In our RAC calculation, we neutralize unrealized losses or gains on securities accounted at fair value. This is because counting unrealized gains and losses in total adjusted capital (TAC) would create more volatility in the RAC ratio and could distort the true picture of a bank's capital adequacy in cases where unrealized gains and losses are unlikely to be realized. Still, while we do not reflect unrealized losses and gains in TAC, we consider their magnitude, their impact on liquidity, and the probability that they could result in realized losses. At the same time, we reduce banks' TAC by the full amount of unrecognized losses for employee benefits.

Risk Position: High And Increasing Concentration In Real Estate-Related Lending

We view Leumi's risk position as reflecting its higher-than-peers concentration. A key risk factor for Leumi and many

of its local peers is its high exposure to property-related lending (see chart 6), namely for construction (16% of portfolio

as of March 2024) and real estate loans (11%). We acknowledge that total exposure to construction and real estate is

below the regulatory limit of 22%, when accounting for risk mitigation techniques.

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